Japan’s New Government Signals Diminishing Outlook for Generics

Proposals on
healthcare reforms, discussed at a high level meeting (DPJ’s Chairman with
officials of MHLW (Korosho) & Ministry of Finance) in Japan last week,
suggest a severe price cut in April 2010 and significant changes in the pricing
policy of long-listed drugs. While still early, these developments indicate a
difficult path for generic companies in particular and all companies with high
long-listed drug exposure in general. This calls for a fresh look at the
DPJ-led government: will they continue to aim for 30% generic penetration (by
vol.) by 2012, or will they attempt to curb healthcare costs of similar
magnitude by alternative mechanisms (reducing long-listed drug prices, etc.)?

Two key outcomes of
the meeting indicate:

• Special Price Cuts
in April 2010:
additional 4-6% price cut may be imposed on the regular price cut scheduled for
April 2010. This would make the total price cut magnitude as high as 10-13%,
badly affecting the companies with high dependence on long-listed drugs, with
Mitsubishi-Tanabe (~80%) and Dainippon-Sumitomo (~50%) facing the maximum
impact. This development is in line with our expectations. We had anticipated
probability of special price cuts in 2009 or a more severe regular price cut in
April 2009 (MP Biopharmaceuticals Outlook 2009). We expect a 90%+ probability
of this taking place. 
• Revised Pricing Policy on Long-Listed vs. Generics: A more
significant development indicates that the Government may attempt to bring down
the long-listed drug prices closer to the generic drug prices. The closer this
difference, the worse it would be for generic companies’ outlook as their
attractiveness would decline. We doubt this will happen immediately,
as the Government will not kill its generic industry but provide room for them
also to survive.
 Generic companies will be pushed to bring
value-added formulations to differentiate themselves and opt for outsourcing
and other cost cutting measures to remain in business. 

These developments are
quite negative for the generic companies (pushing down major generic companies’
price by double digits), and we expect chaos to continue until Jan-Feb ‘10,
when the government’s specific course of action should become more lucid. 

A Number Of Other Reforms Are Underway: Led by the previous
government, a number of short term and long term reforms should take shape in
the coming years. The short-term reforms (in the next two years) inlcude
expansion of the number of DPC (Diagnostic Combination Procedure) hospitals,
increase in dispensing fees, increase in the number of reviewers, and better
clinical trial infrastructure and support, etc. The short-term reforms will aim
at decreasing ‘Yakka-sa’ and ‘Bungyo’. Long-term reforms under discussion
(which will shape up in 3yrs+ time horizon) include DPC for out patients, free
pricing for generic companies, no price cuts during patent period, etc. While
some of the reforms are already underway, a longer term realization will
eventually determine the shape of Japanese pharma. 

Healthcare Reforms Are An Ongoing Process: Healthcare reforms are
not something new in Japan. The idea of generics was first proposed by MHLW in
‘The Final on Pharmaceutical Industry in 21st Century’ in 1993. Continuous
biannual price-cuts, revising-up number on DPC-hospitals, and Koro-Sho
(MHLW)-induced active dialogue between various interest groups over time have
evolved into the current, more meaningful set of changes. 

Recent and most significant changes were introduced by the LDP-led government
in April 2008. They were aimed at increasing the use of generic drugs to 12% by
2010 (from 2007 level of 5.2% by value). Japan currently lags far behind other
regulated markets in terms of generic use: 16.8% in Japan versus 54% in USA,
52% in UK, and 55% in Germany, by volume. Key factors that contribute to poor
generic uptake in Japan are: 
1) low margins received by doctors and pharmacies from generics drugs, 
2) imbalance in bargaining power of different interest groups, 
3) poor management quality of generic companies, and last but not least,
4) psychological barriers that enforce both doctor and patient misconceptions
that generics are inferior! 

Reducing Healthcare Expenditure at the Cost of Innovation? Alleviating
the healthcare burden by means of increasing the use of generics is a real-time
need, but no Japanese government can afford to compromise on its established
innovation-driven pharma, especially when the number of employees with large
pharma companies are much higher than those with generic companies. This
fundamental concern prevents governments from outright favoring generic
companies and calls for a different mechanism of reducing the healthcare cost
while hurting innovators companies least. There are numerous steps already
under way that will help innovator pharma companies in the long run. 

Key to these reforms is an increase in the number of reviewers at PMDA, changes
in the drug pricing policy, removal of price cuts during patent period and
strengthening the country’s clinical trial infrastructure. 

In general, drugs in Japan are launched at ~70% price (to the US level). The
average time taken to launch new drugs of foreign origin in Japan is the
highest among all regulated countries — it was 3.8 years in 2004 (v. 1.4 years
in US and UK, and 1.6 years in Germany). The major reason behind this disparity
is the difference in review time or process, which is directly proportional to
the number of reviewers with different regulatory authorities of different
countries. The total number of employees in PMDA (Japan’s
equivalent of US FDA)was just 356 in 2006. The Japanese Ministry of
Health and Labour Welfare’s new mid-term plan aims to add 236 additional
reviewers by the end of 2009. 

The proposed key features for the ‘New 5-Year Clinical Trial Activation Plan’
aim to attain specific targets in building a clinical trial infrastructure,
human resource development for clinical trials, public promotion of clinical
trails, and encouraging efficient clinical research management and sponsors
support. Besides these objectives, “no price cuts during patent period”
and “cost-based pricing” are also important actions that are under

Outlook For Specialty Pharma Sub-Sector Is The Most Difficult: Four
global Japanese companies (Takeda, Astellas, Daiichi-Sankyo and Eisai) generate
a significant (30%-60%) portion of their business from overseas. Toughening the
domestic market keeps these companies further away from making large
investments in the domestic market, while focusing on increasing their overseas
base. Nevertheless, each of these companies is going to face significant patent
expiries in the near future and their current pipeline appears inadequate to
fill the nearing gaps. Thanks to the traditionally strong cash position of
Japanese Pharma companies, the result has been a series of overseas
acquisitions to help face the challenges in the future. 

‘Second-tier’ companies like Mitsubishi-Tanabe, Dainippon-Sumitomo, Ono, and
Kyorin, however, depend largely on domestic markets and heavily on long-listed
drugs that are exposed to the threat of generics. New pricing policy, which may
bring down their long-listed drug prices closer to generics, will protect their
revenue but this will be a net loss on their bottom lines. Their inability to
neither develop drugs overseas nor achieve sustainability in domestic markets
may push them to join hands with local companies of similar interest, or to
enter into generic space themselves. Five of the top ten Japanese companies are
a result of the recent merger wave, and among specialty pharma companies
Mitsubishi-Tanabe and Dainippon-Sumitomo represent classical examples of
‘cost-synergy’ becoming the biggest driver of consolidation.

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